Interest rate rise: When might it happen and what would it mean?

02/12/2021

Inflation is expected to hit 5% in 2022, which experts predict will spark an interest rate rise. Discover what this could mean for your finances.

Date posted: 02/12/2021

Figures released by the Office for National Statistics show inflation rose to 4.2% in October 2021, the highest it’s been for nearly a decade. It leapt from 3.1% the month before, largely blamed on rising energy prices and supply shortages in the wake of Covid.

The figures are stark and predictions from the Bank of England (BoE) provide little comfort. It suggests inflation will exceed 5% in 2022 – more than double the Bank’s 2% inflation target.

While rising inflation would historically be controlled by increasing interest rates, in November 2021 the BoE decided against increasing its historically low rate of 0.1%. Read on to discover if rates might increase soon and what it might mean for you if they do.

Before we do though, let’s look at what inflation is.

Inflation is the increasing cost of living

As inflation is the rising cost of goods and services, it can affect most areas of your day-to-day life, from the cost of the weekly shop to the amount you pay for fuel. Because inflation means £1 buys you less tomorrow than it does today, it has the potential to devalue your hard-earned cash in real terms.

If you use an inflation calculator, you’ll see that you need £132 in November 2021 to have the same spending power as £100 in 2011. In other words, your money would have needed to have grown 31.6% to offset the average inflation rate of 2.8% during the 10-year period.

Increasing interest rates could help to slow rising inflation

Interest rates can be an effective way of keeping inflation under control as they can help stop spending. As a key driver of inflation can be the demand created by spending, higher interest rates can make saving a better option than spending, reducing demand in the process.

Against this backdrop and inflation reaching 4.2% in October 2021, the Times reveals that experts predict interest rates could reach 1% by the end of 2022.

Interest rates look set to increase in 2022

While this may be good news for savers who have had to endure years of historically low interest rates, it may not be so welcome if you have a loan or mortgage. We also need to consider what it might mean if you have investments?

So, against this backdrop, let’s look at how it could affect your finances.

Mortgage

High street banks and other lenders typically use the BoE’s interest rate to set their mortgages and savings rates. While they do not have to increase them in line with the BoE, they’re likely to, meaning you will pay more for bank loans and mortgages.

To demonstrate this, consider the following example that Fidelity provides. It shows that if you have a £150,000 mortgage with 15 years to run, and pay an interest rate of 1.5%, you could see your repayment increase by £16.98 each month if the rate rises by 0.25%.

If you have a tracker mortgage you could see an immediate change to your monthly payments, as rates are typically directly linked to the base rate. With a standard variable rate (SVR) mortgage, lenders are likely to adjust it so that it’s in line with interest rates.

The good news is that if you already have a fixed-rate mortgage, it’s unlikely to be affected until your agreed period runs out, at which point your rate will probably revert to the lender’s SVR.

Savings

Like mortgages, banks do not have to increase the rate of interest paid to savers if the BoE increases its interest rate. That said, if they want to attract savers’ cash they could decide to.

Fidelity calculates that if you have £20,000 in the highest paying easy-access savings account in November 2021, you could see a return of 0.65%. This means you could receive £660 of interest on your money over five years.

If the rate were to rise by 0.25%, your return would rise to £920.

Investments

It’s difficult to know how an increase in interest rates could affect investments. One way it might would be to bring the price of fixed-income investments such as bonds down.

This is because higher interest rates mean potentially higher returns from low-risk assets like cash. As such, bondholders will want higher returns – or yields – to stay invested, which would mean the price of bonds come down, which could be detrimental to your investments.

The opportunity for better returns from cash and reduction in bond values could create uncertainty in the markets. Remember that if the markets take a downturn, riding it out and waiting for them to potentially grow again may ensure you don’t lock in any losses by cashing in your investments.

In the long term, investing typically outperforms cash savings. This was demonstrated by the 2019 Barclays Equity Gilt Study, which tracked the nominal performance of £100 invested in cash, bonds or equities between 1899 and 2019.

It reveals that £100 invested in cash in 1899 would be worth just over £20,000 in 2019. If the money had been invested in stocks and shares, however, it would have been worth around £2.7 million.

Please note that past performance is not a reliable indicator of future results. There are no guarantees of returns on any investment

Speaking to us could help

As your financial planner, we could help you understand what’s happening with interest rates, your investments and the market. This could help provide peace of mind around your investments, helping you create opportunities for potential growth and reducing the chances of you making a decision you then later regret.

If you’d like to discuss the situation with interest rates and your wealth, please get in touch by emailing info@douglaswhiteltd.com or calling 0151 345 6828. If you know anyone else who might benefit from a discussion about rising interest rates, please let us know as we’d be happy to help them.

Please note

This article is for information only. Please do not act based on anything you might read in this article.